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Introduction

Warnaco Group (WRNC) is a $1.64 billion company in the apparel and accessories industry. Market capitalization competitors in this industry include Columbia Sportswear, Jones Apparel, and Quiksilver. The apparel and accessories industry is down 10.75% over the past year compared to the S&P 500 which is down 4.15% during the same period. Over the past month, the industry has been up 0.56%, while the S&P 500 has been down 6.12%. After a strong sell-off earlier in the past year, there is a strong potential for apparel companies to grow. Evidence comes from a potential low in retail and apparel stocks, with a possible breakout inevitable. Warnaco’s growth and valuation illustrate the potential for a strong earnings report next quarter.

Business

This section describes what Warnaco produces. According to Reuters, Warnaco “designs, sources, manufactures, markets, licenses and distributes a line of intimate apparel, sportswear and swimwear worldwide.” Some of the familiar brands produced in this model include Calvin Klein, Speedo, Nautica, and Chaps. As Reuters suggests, Warnaco not only designs and manufactures these lines, but the company is active in organically selling the products to consumers. Warnaco operates hundreds of Calvin Klein stores, many Lejaby retailers, and an online Speedo shop. Specially, the company separates its business into three segments: Sportswear, Intimate Apparel, and Swimwear.

Beginning with Sportswear, this group has a vertical operation of men, women, and child’s sportswear. Products include jeans and woven shirts, both majority coming from the Chaps and Calvin Klein brands. Most products are sold in independent retailers and chain stores, but some products are sold through specialty stores. However, what’s important is that Warnaco operates outside the United States. About 43% of all sales are outside the United States for Sportswear and the other two business segments. With the dollar continuing to decline (especially with interest rates falling substantially over the past couple of months), there is a great opportunity for exporting nations to take advantage of cheap U.S. prices and purchase these apparel products.

The international success not only applies to the Sportswear segment, but to the intimate apparel segment as well. This segment focuses on producing underpants and loungewear for both men and women. About 36% of all sales come from this segment, which includes countries such as Canada, Switzerland, Singapore, and Belgium. The main brands for this segment are Calvin Klein, Olga, Warner’s, and Lejaby. Most products are sold through department stores and chain retailers.

Warnaco’s last business segment is swimwear. About 21% of total revenues come from the production of “swimwear, fitness apparel, [and] swim accessories.” Most of the swimwear branding comes from Speedo, which helps distribute its product through the company’s website, alongside department and specialty stores. Most of the products are targeted for women with regards to designer swimwear, while accessories (goggles, toys, electronics) are targeted to all ages. Once again, the swimwear group has an international exposure.

Growth

Warnaco has illustrated solid growth prospects over the past year. According to Reuters, Warnaco reported a $1.83 billion revenue product last year. This number is over 19.45% higher than it was the previous year. Compared to the industry’s average of 18.06%, there is definite growth regarding this company. The same result is true for earnings. Warnaco saw EPS growth rise an incredible 76.51% last year—a growth rate much higher than the industry’s 14.87% average. More detailed, even juxtaposed to similar market-cap competitors illustrate strong results. Columbia only reported an 8.15% increase in revenue and a 14.13% increase in EPS over the same time period. Quiksilver saw respective numbers of 10.26% and -207.68%. Even more dramatic, competitor Jones Apparel reported its respective numbers of negative 1.83% and negative 182.73%. Therefore, there is strong evidence that Warnaco is growing, despite problems in the industry and overall economy.

However, investors may question the aforementioned growth after seeing the company’s margins. According to Reuters, Warnaco reported gross, operating, and net profit margins of 40.82%, 8.14%, and 4.60% last fiscal year, respectively. These numbers were much lower than the industry’s average figures and the company’s five year average figures. However, in situations like this one, it is important to look at trends and historical figures. On a five year average, Warnaco reported gross, operating, and net profit margins of 33.45%, 36.56%, and 32.05%, respectively. With the exception of gross margins, operating and net income margins beat the industry’s five year respective averages of 17.76% and 11.53%. In addition, the company’s five year averages also beat certain competitors. Columbia’s five year respective operating and net income margins are 17.54% and 11.59%. Jones Apparel only reported 8.75% and 4.71% respective margins. And Quiksilver’s numbers were even worse at 6.72% and 2.83%, respectively. Therefore, while Warnaco’s current margins are not great, history illustrates previous success. Thus, there may be the potential for similar margins nearby, which should propel the company’s share price.

Like Warnaco’s margins, the company also reported less than stellar ROE figures during the past year. ROE figures came out at 12.14%, while the industry reported an average figure of 22.81%. While the difference is quite wide, Warnaco actually produced better than some of its market-cap competitors. Jones Apparel reported an ROE of negative 5.91%, and Quiksilver reported a negative 11.16% figure. Moreover, Warnaco has a strong history when it comes to returns. While Reuters does not supply the company’s five year average ROE, Reuters does supply Warnaco’s five year ROA (38.46%) and ROI (49.57%) averages. Both figures are significantly above the industry’s five year averages of 15.95% and 21.38%, respectively. These numbers are also higher than all three direct market-cap competitors’ respective figures. Therefore, while Warnaco had a difficult year, ROE and margins wise, its history illustrates success—making revival achievement a strong option in the future.

Valuation

With the company’s current growth and margin numbers below normal figures, Warnaco’s share price has taken a hit. However, there is evidence to believe the hit is too hard. Currently the industry supports a P/E ratio of 17.66 and a price to sales ratio of 2.03. Forward looking, Warnaco sees its P/E ratio at 15.57 and its price to sales ratio at 0.86. However, because Warnaco has had such a great history with regards to sales, earnings, and margins, the company’s share price may be undervalued. For example, Quiksilver has a forward P/E ratio of 15.37. While the number is below Warnaco’s figure, Quiksilver should be even lower given the company’s current and historical figures. As pointed out above, Warnaco has beaten Quiksilver in most growth categories both in the present and past and therefore has a great opportunity to grow share price wise over Quiksilver. More evidence comes from the PEG ratio. Warnaco currently has a PEG ratio of 0.81, given a five year growth rate. Quiksilver has a 0.98 ratio, Jones Apparel has a 1.20 ratio, and Columbia’s ratio is high as well at 1.05. Therefore, given the growth expectations at the current share price, there is significant evidence to illustrate that Warnaco is undervalued in this industry.

Efficiency

Warnaco is efficient. The company's receivable turnover of 6.24 is good compared to industry competitors (Columbia: 3.49). Warnaco manages to collect cash from consumers every 104 days. Inventory turnover at 3.12 also follows a respectable pattern compared to the industry’s 3.12 number. Moreover, asset turnover is also strong at 1.12. In terms of liquidation, Warnaco’s current ratio is 2.48—a solid number related to debt and equity purchases. This statistic coincides with the company’s low debt to equity ratio of 0.51. Some investors may question low debt financing, but the lines of liquidity are uncertain now. Once interest rates fall a bit more, the company may take one some more risk. Moreover, institutions own 95.00% of all Warnaco shares. Since the institutional investors have a larger gross amount of capital to lose compared to the retail investor, a high institutional percentage illustrates confidence in the stock's ability.

Technical Analysis

Warnaco performed nicely in 2007. The company’s share price has increased 33.02% year-to-year. This type of growth is excellent for a recessionary-type economy. There seems to be some support at the 30 dollar share price range dating back to earlier January 2008. The last time Warnaco reached this amount the company rebounded and appreciated 17%. There is a possibility a similar situation could occur in the future.

More specific to the current month, Warnaco illustrates strong technical signals. The 50 day SMA and 50 day EMA have converged after the $34 mark, signaling a support level. The convergence will possibly lead to a strong outbreak in the coming months and weeks. The company is a little undervalued compared to the RSI index at 47.24, but it is better to be an advocate of fundamental valuations before technical valuations. Therefore, while now isn't the most ideal time to purchase shares of Warnaco according to technical analysis, purchasing shares will still produce strong long terms gains.

Conclusion

Warnaco is a great acquisition for any portfolio. The company's business model and fundamental analysis are both strong. It is very rare to find a company that has both strong valuation and growth, so it is wise to take advantage of these situations as they arise.

-Dennis Biray
February 1st, 2008